Is the honeymoon over for India’s IT services companies?

Demand for outcome-based IT services contracts will reduce India's traditional advantage as businesses begin to pay service providers based on improving business, rather than for time and materials. Could this spell the end of the decade-long honeymoon for India's IT outsourcing sector?

Demand for outcome-based IT services contracts will reduce India's traditional advantage as businesses begin to pay service providers based on improving business, rather than for time and materials. Could this spell the end of the decade-long honeymoon for India's IT outsourcing sector?

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Indian suppliers got their foot in the door of the global IT market just before 2000, when global businesses, worried about the Millennium Bug, needed lots of software resources to prepare for the worst (see panel below).

As a result, Indian technology companies which had been around for years developed relationships with global enterprises. The big attraction to big business was the availability of good software engineering skills at a fraction of the cost of home-grown equivalents.

Changing times

India's IT sector remains confident but recognises it needs to change. Som Mittal, president of Nasscom, the body that represents Indian IT suppliers, recently told the Financial Times that he expects the Indian services sector to grow 15%, to be worth $70bn this year, despite the challenges it faces.

But despite this confidence, a confluence of factors could mean the Indian suppliers will face reducing profit margins. These factors include a trend towards businesses paying for services based on outcomes rather than time and materials used, wage inflation in India and a tightening up on the rules regarding work visas in the UK and US.

Mittal accepted that outcome-based agreements changed the game and will force Indian suppliers to become more efficient.

Mark Lewis, head of outsourcing at law firm Berwin Leighton Paisner, says the honeymoon is over for Indian global IT and outsourcing players. "They now have to face the same challenges as their other global competitors. Join the club, as it were."

He says there is now a cost base issue for the Indian suppliers: "As the Indian economy has grown and continued to grow, so has GDP inflation and wage inflation, especially in the software engineering sector. So people who used to be cheaper than infrastructure are now much more expensive than they were."

Douglas Hayward, analyst at IDC, believes the Indian IT industry has accepted things are changing and is adapting to it: "Indian suppliers realise now they are moving to the end of the golden-age of time and materials and throwing people at a problem."

"They have already moved into fixed-cost deals from time and materials and outcome-based contracts are the next step."

Room to develop

Ilan Oshri, associate fellow at Warwick Business School, believes India still has much room for manoeuvre: "There are rising costs but people are shifting to different cities where costs are lower. They are not just using cities like Mumbai and Chennai, but also southern India." He says his research actually shows an increasing trend for Western businesses to set up captive centres in India.

Ilan Oshri says outcome-based contracts are becoming more popular but still only account for a small portion of total contracts. "Outcome-based contracts are the smallest portion of contracts, so it does not have a real impact at the moment." He agrees with Hayward that outcome-based deals are not a major step from fixed-cost agreements.

Indian companies are noting a change in buying habits. Bindi Bhullar, director at Indian supplier HCL Technologies, says in the UK there is a trend towards outcome-based contracts. He says customers are becoming more sophisticated in their purchasing of IT services: "Even first-time outsourcers can use outcome-based contracts if they have the right advisory support."

But he adds that there is still a future for the time and materials model. "It still suits a lot of customers and when you look at the overall market there is still relatively low penetration."

Indian IT service providers face a challenge to retain their strong position in the global outsourcing sector. The last decade has seen Indian companies outgrow their competitors but have they prepared for shifts in customer buying habits, geopolitics and economic change?

It is a story of missed opportunities for western IT giants. He said: "The suppliers in the west only started to feel threatened by us in 2000."

"Before 1994, western IT companies were not really noticing us because we were mainframe maintenance. Then client/server came they thought we could not do it. But we were."

When the year 2000 approached, Indian companies took their opportunity. Soota said: "Then Y2K came along (millennium bug) and they thought we would go away afterwards. But Y2K gave Indian companies entry into big global companies."

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